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The consensus view in the market is that government shutdown doesn’t matter much – been there, done that – but the debt ceiling issue is the real deal. And the reason for that is that the consequences of debt default, howsoever temporary or technical, will be catastrophic for everyone.

The resulting credit downgrade and spiking interest rates will create a stampede in the market as Treasury bondholders sell their positions in panic. The market shock and turmoil could very well exceed what we experienced in the fall of 2008, post the Lehman bankruptcy. Default would make a thus far risk-free asset into non-performing, creating a royal mess on banking and corporate balance sheets. Beyond the immediate effects, one could envision long-term consequences for the country’s economic standing and the U.S. dollar’s global reserve currency status.

All of these are arguments no doubt make a lot of sense, but I am having second thoughts about how big of a deal a debt default actually could be. After all, the default will only be a technical one, resulting from Congress’s inability to raise the debt ceiling. Couldn’t the market see through that fog and judge the country’s creditworthiness based on actual fundamentals and not some technical credit event?

I am by no means suggesting a debt default or applauding Congress’s brinkmanship. But I find it hard to buy into some of the scary scenarios that will supposedly result from this type default either. Yes, default will have consequences, but perhaps they will be far more benign than the Lehman analogies that are being bandied about.
Isn’t the market smart enough to tell a real default from a phony (technical) one?

What do you think?

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